Session 1B. CONCEPTS
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CONCEPTS
Consumption: Direct and final use of goodsdestruction of utility.
Savings are that part of the income which is
not used for current consumption- i.e.,
Postponement of current consumption
S = Y-C
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Investment: Savings when mobilised and
converted into real physical assets
Production: Creation or addition of utility
Productive activity: Any activity undertaken
with the objective of earning an economic
reward
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CONCEPTS
Factors of production
Land
• All natural resources lying on, above or below
the earth’s surface
• Heterogeneous
• Geographically immobile but occupationally
mobile
• Passive factor of production
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CONCEPTS
Factors of production
Labour
• Physical or mental exertion by a human
being in the process of production
• Heterogeneous
• Inseparable from the labourer
• Active factor of production
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CONCEPTS
Factors of production
Capital
• Produced means of production
• Factories, machines, tools, buildings etc
• Derived demand
• Subject to depreciation
Money Capital: Money funds at the disposal
of a firm or individual
Real capital: Physical assets. E.g.,
machines, buildings, etc
Human capital: Skills, knowledge and
health of labour as a factor of production 6
CONCEPTS
Factors of production
• Enterprise & Organization: Newer
concepts
• Identifying potential sources of production,
collecting them in required quantities,
assigning them specific tasks as per skills
is the role of Organisation.
• Using these factors for economic activities,
without any certainty of returns is the
function of the entrepreneur.
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CONCEPTS
Concept of scarcity- Scarcity of resources
and multiplicity of wants- Choice
Opportunity Cost: Benefits foregone from
the alternatives that are not selectedarises from scarcity and versatility of
resources
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PPC/PPF or Transformation
Curve
Production Possibility Curve/ Frontier
• A graph that shows the different
combinations of the quantities of two
goods that can be produced (or
consumed) in an economy, subject to
availability of resources
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PPC/PPF or Transformation
Curve
• PPC represents opportunity cost concept
and measures it (through the slope)
• Highlights significance of scarcity of
resources
• Shows trade-off
“Substitution is the law of life in a full
employment economy. The PPC depicts
the society’s menu of choices”Samuelson
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PPC/PPF or Transformation
Curve
Imagine an economy that can produce only
wine and cotton. According to the PPF,
points A, B and C - all appearing on the
curve - represent the most efficient use of
resources by the economy. Point X
represents an inefficient use of resources,
while point Y represents the goals that the
economy cannot attain with its present
levels of resources.
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PPC/PPF or Transformation
Curve
Assumptions:
• Economy is operating at full employment
• Factors of production fixed in supply; but can be
reallocated between uses
• Technology unchanged
• For simplification, considers only 2 commodities
Based on these assumptions, society is faced with
a fundamental problem of choice
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PPC/PPF or Transformation
Curve
• PPC measures the best combination of
outputs that can be achieved from a given
number of inputs.
• Downward sloping . Why?
• Concave to the origin (bowed outside)- As
we produce more units of a commodity,
we have to give up more and more units of
the other commodity
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Shifts in PPC
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PPF
• When the PPF shifts to the right
(outwards) , it shows there is growth in an
economy..
Reasons:
• Technology
• Factor Endowments (shale Gas)
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PPC
• When the PPF shifts inwards, it indicates
that the economy is shrinking.
• A shrinking economy could be a result of
huge ecological disaster , social unrest or
deficiency in technology
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PPC
• An economy can be producing on the PPF
curve only in theory. In reality, economies
constantly struggle to reach an optimal
production capacity.
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Firm
• An entity or organization that combines
and organizes resources for the purpose
of producing goods and /or services for
sale.
• Identify- collect -and assign resources
• Types: proprietorships, partnerships, and
corporations
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Sole Proprietorship Firm
Sole Proprietorship Firm/ Proprietary
Single owner
-Invests own/borrowed capital
uses his own skills in management, solely
responsible for results of operations
-Profits / losses not shared by anybody
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Advantages:
• Simple form
• Easy to start and exit
• Undivided profits
• Secrets of Trade
• Prompt decision making
• Personal touch to business
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• Disadvantages:
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No separate entity of the firm
Unlimited liability
Limited availability of funds
Uncertain life of business after the owner
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2. PARTNERSHIP
• Association of two or more persons
• Agreement/ contract to start the firm and to
share profits (& losses)
• Individually partners , collectively firm
• Heir does not automatically become partner
• All partners are bound by a decision or act by
any one of them.
• A partnership firm can not become a member of
another firm, though partners can join another
firm
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PARTNERSHIP
• Partnership Deed- as partnership is
created by agreement
- Easy to form
- Strong credit position
- Shared Risk
- Shared resources
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PARTNERSHIP
• Uncertain life -Can be broken any time
and reconstituted
• Unlimited liability- if a partner can not
repay loan, creditors can claim it from the
his personal assets.
• No legal framework for defining partners’
roles- Distrust can destroy
• Fund availability related to partners’
creditworthiness
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JS/ LTD COMPANY
Most common type of business organisation
Legal entity
Perpetual Existence- independent of its
members
MOA and Articles of Association to registrar
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Private and Public Ltd Co
Private LTD Co:
-Max 50 share holders
-Shares transferable only among members
- Cant issue a prospectus
Public Ltd Co:
Minimum 7 members, no max
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Business Cycles
• Widespread contraction and expansion in
most sectors of the economy.
Peak
Trough
Time
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Phases of Business Cycles
Phases of Business Cycles
• Expansion
• Peak of boom or prosperity
• Recession or downturn
• Trough, the bottom of the depression
• Recovery and expansion
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• Business cycles are marked by
widespread expansion and contraction in
most sectors of the economy
• Major phases of a business cycle are
recession and expansion (or prosperity).
• Peak and trough are the turning points of
the phases.
• If recession is severe in terms of scale and
longer in duration, it is termed depression
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Causes of Cycles
• Inflationary/ deflationary pressures on
price-cost relationships
• Agricultural and meteorological factors
• Aggregate demand and under
consumption
• Monetary factors
• Savings-investment gap or over
investment
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Causes of Cycles
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Technological innovation
General over production
Psychological factors
Risk and uncertainty factors
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Characteristics of Recession
• Fall in consumers purchase
• Fall in demand for labour and other inputs.
• Fall in output and increase in inventories.
• Fall in investments and demand for credit
• Fall in profits
• General pessimism
Increase in the above factors describes the
phase of expansion
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Characteristics of Recession
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The Great Recession:
Fall in Durable consumer goods demand
Freeze on new recruitments
Job cuts and pay cuts
Unsold houses (Foreclosures)
Bankruptcies
Stock market slide and falling investor
confidence
• General mood of pessimism
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Global Recovery??
• US sub prime lending
• Each phase carries the seeds of its own
destruction
• Jobless recovery??
• Double Dip??
• European crisis: Sovereign Debt Crisis
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Signs of Economic Recovery
1. Unemployment figures
• Non-farm payrolls
• ASA Staffing Index: Measures the
temporary staffing activity. After a
recession, employers add temporary
workers first so as to avoid the
commitments and expenses of adding fulltime workers until they are sure that
business has improved. A rising ASA
Staffing Index can signal that a recovery is36
Signs of Economic Recovery
2. Consumer spending
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Signs of Economic Recovery
3. Consumer Sentiment
Surveys ask people how they feel about
the economy in near-term and their own
individual or family prospects.
• Consumer sentiment indicators like the
Consumer Confidence Index (CCI) and the
Michigan Consumer Sentiment Index do
seem to correlate with reality more often
than not.
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Signs of Economic Recovery
4. Bank Lending
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5.Purchasing Managers Index
(PMI)
• The Institute for Supply Management
(ISM) calculates the Purchasing Managers
Index (PMI)
• Composite index of five "sub-indicators",
based on surveys of more than 400
purchasing managers from around the
USA
• whether businesses are seeing new
orders, higher production levels, timely
deliveries from suppliers and increasing 40
Signs of Economic Recovery
• Production level
• New orders (from customers)
• Supplier deliveries - (are they coming
faster or slower?)
• Inventories
• Employment level
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Signs of Economic Recovery
• Questions have only three options;
"better", "same", or "worse“ (As the
manager sees it)
• PMI figure ranges from 0 to 100
• PMI reading of 50 would indicate an equal
number of respondents reporting "better
conditions" and "worse conditions".
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Signs of Economic Recovery
6. Cass Freight Index and the American
Trucking Association's Truck Tonnage
Index. (because these show that goods
are being delivered to satisfy consumer
orders)
• In India also truck sales are taken as an
important indicator
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Contra Cyclical Policy
Contra-cyclical or Counter-cyclical Measures
(Measures to control business cycles)
A) Monetary Policy for Tackling Recession–
Designed by the central bank of the country.
(RBI in India) Monetary measures control
liquidity and availability of credit .
Need to increase liquidity through:
• Repo and reverse Repo rates
• CRR decrease
• SLR decrease
• OMO: Selling securities Moral suasion and other44
qualitative credit controls
B) Fiscal Policy for Tackling
Recession
Measures by the government- Emphasised by
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J. M. Keynes during Great Depression
Reduce tax rates
Increase subsidies
Increase public expenditure
Debt polices.
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Fiscal measures directly affect
• Prices
• Consumers’ disposable income
• Money supply
• Supply of goods and commodities
- which in turn affect the movements of
business cycles
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3.Other measures –
Buffer stock operations
Declaration of minimum procurement price
etc are used to stabilize prices in
agriculture
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Inflation
• Demand pull/ Cost- push
• WPI: 435 commodities tracked- time lag of
only e weeks- revision later
• CPI is a better index as it captures cost of
living, but it comes with a time lag
• 4 types of CPI- Industrial workers, urban
Non manual workers, AL, rural labor
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Monetary Policy
• Repo rate : Rate of interest charged by
central bank when banks borrow money
from it
• Tool through which RBI infuses funds into
the system by lending to banks against
pledging of securities
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Monetary Policy
• Reverse repo: Rate which RBI offers to
banks when they deposit funds with it.
• RBI drains out liquidity from the financial
system through reverse repo by releasing
bonds to the banks. This is a daily
operation by the Bank to manage liquidity.
Over a longer period, RBI can also
manage liquidity through OMO.
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Monetary Policy
• When liquidity is tight and banks need
short term funds from RBI to manage
mismatches, then repo rate emerges as
the effective policy rate.
• But if liquidity returns to the system
reverse repo rate would become the
operative rate as RBI would be draining
out funds from the system,
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Monetary Policy
• . In US there is a single Fed Fund Rate. This is
the key interest rate and short term funds are
available to eligible borrowers at this rate.
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Policy Rates
• SLR• Every bank in India has to maintain a minimum
proportion of their net demand and time liabilities as
liquid assets in the form of cash, gold and unencumbered approved securities.
• Statutory Liquidity Ratio (SLR). Simply put, SLR is the
percentage of total deposits banks have to invest in
government bonds and other approved securities
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• The maximum limit of SLR is 40% and
minimum limit of SLR is 25%. It’s 25%
now. This restriction is imposed by RBI on
banks to make funds available to
customers on demand as soon as
possible. (Gold and G Secs (or Gilts) are
included along with cash because they are
highly liquid and safe assets.)
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CRR, or cash reserve ratio, is the portion of
deposits that the banks have to maintain
with the RBI.
Higher the ratio, the lower is the amount that
banks will be able to use for lending and
investment
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Difference between SLR and CRR:
• To meet SLR, banks can use cash, gold or
approved securities - CRR has to be only
cash.
• CRR is maintained in cash form with RBI,
where as SLR is maintained in liquid form
with banks themselves.
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Reverse logic in recession
• A cut in SLR means that the home, car
and commercial loan rates will go down.
•
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Find out Policy Rates as in Sep.
2010
• Repo Rate:
• Reverse Repo:
• CRR:
• SLR:
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FISCAL MEASURES
Recession:
• Increase government spending (stimulus
packages)
• Reduce taxes
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ROLE PLAY
• Company XYZ earns 70% of its revenue
from exports to USA.
• Of late export orders have fallen , leading
to fall in revenues.
• A meeting is called to find out solutions to
the crisis.
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Role Play
• The HR manager wants to cut jobs
• Finance department does not want to cut
jobs as he does not want to lose trained
manpower who will be handy in the case
of a recovery.
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• Product manager wants to create new
products by investing in R& D
• The Marketing Department is not sure
new products can be sold in a recession.
they have 2 suggestions: A) more
advertisements for the old products
• B) Concentrating on domestic demand
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• The IT Department wants to keep more
people ready for future demand
• How will a decision be arrived at?
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END of SESSION
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Indian Economy,2010 Performance & Prospects
• All round prosperity
- Wealth effect of rising prices of most assets-real
estate, gold, stocks
-Up to 30% hike in MSP of food grains
Farm loan waivers
Increasing private sector salaries
-Higher than ever hike in PSU salaries in the past
5 years (14% in 2006-07, 26% in 2007-08,
31.2% in 2008-09)
Family incomes have risen faster than individual 65
incomes because of spread of service sector
• Rise in the number of double income
families
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According to NCAER
• How India Earns, Spends & saves by Rajesh
Shukla:
• Rising middle class numbers
• Rural jobs growing (Expenditure on NREGA :
• 07-08: Rs.15,857
• 09-10: Rs. 37, 938
• 10-11: Rs. 40,100
• NREGA wage rates have gone up from Rs.80 to
Rs. 100
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• Rural economy is no more synonymous
with agriculture
• Every new car creates 5 new jobscleaner, driver, parking attendant,
mechanic & auto insurance surveyor
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• According to Morgan Stanley report, the
Indian economy will start growing faster
than China in 2013.
• Reason : demographic dividend- India
will see a declining trend in the share of
non-working population and add 136 mn to
working population over the next 10 years;
China, only 23 mn.
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• India’s savings rate will go up, while share
of consumption in China’s GDP will go up
• Assumptions:
• Sustained increase in India’s infra
spending,
• Educational levels
• Fiscal consolidation.
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Read Raghuram Part II
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Raghuram Rajan: Fault Lines: How Hidden
Fractures Still Threaten the World Economy
• We must create real jobs,- not make-work jobsto increase productivity of rural worker to the
levels of manufacturing/ service workers
His prescription for population dividend:
• Infrastructure
• Education
• Health
• Financial Inclusion- credit only one aspect
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ET’s warning:
• Need inclusive growth and internal
security.
• To tackle the second, you need inclusive
growth
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On china (From Economist
19/08/10)
2010 (2nd quarter) output:
US:
$ 3.522 trillion
China:
$1.337 trillion
Japan:
$ 1,288 trillion
China is now world’s 2nd largest economy,
having surpassed Japan in the 2nd quarter
of 2010
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China- Some Facts
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World’s largest population
World’s largest exporter
World’s largest car market
World’s largest consumer of energy
World’s largest carbon emitter
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China’s problems:
Inequality
All areas not fully developed
Rural neglect
Absence of democracy
Trade wars with Us
Strikes in plants
Housing bubble?
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Role Play
Company XYZ is an exporter whose major
profits come from the US market. Of late, it
has been facing falling demand and
dropping profits. A meeting is called to
discuss the problem:
The HR head wants to reduce manpower
to revive profits.
The operations head wants to have a
stable workforce which is well-trained and
highly skilled so that resources do not
migrate to competitors and morale is not 80
The Product Development head wants
increased R&D spending so that new
product lines can help beat the falling
demand.
The Finance Head wants to avoid any new
investments because the company has
limited capital and will be hit hard if new
products do not do well.
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The Marketing Head has two alternatives :
Either explore new foreign markets or to
launch an exciting campaign to rejuvenate
domestic demand.
What should the Managerial Economist Do?
What lessons did you learn?
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